Annuities underpin retirement income – and the certainty of that income – for many investors/ retirees: but what are annuities; and how can I benefit from having one? The following post describes the general application of annuities, but over time, new retirement income stream products are developed and it is wise to seek professional financial advice before entering into an annuity contract, to ensure that what you are securing is in your best interests – and that you understand the product.
What is an annuity?
An annuity is an income producing investment that provides you with a guaranteed level of income. It is purchased with either superannuation or non-superannuation money. Life insurance companies are the main providers of annuities.
An annuity is a contract between you and the provider. It is the responsibility of the provider to invest the underlying asset and bear the risk of the investments. The annuity will pay you the agreed payments irrespective of market movements. In these features, they help secure your retirement income at the levels you would like to enjoy.
How is the income paid?
Annuities can be paid for a fixed term or for your lifetime. You choose the length of the payments for a fixed term annuity. The minimum term for an annuity is one year. An annuity that is paid for a fixed term is called a ‘term certain’ annuity.
You can generally choose to receive annuity payments monthly, quarterly, half-yearly or yearly. You may also wish to have these payments indexed to CPI (inflation) or another fixed amount.
How is your capital returned?
With an annuity you are able to choose how much of your capital you wish to be paid back to you over the life of the annuity and how much you wish to receive when the annuity has expired. Once the annuity is in place, it is not possible to make a withdrawal of any capital other than what is scheduled under the initial agreement,
The amount of capital left at the end of the annuity period is known as the Residual Capital Value (RCV).
When you purchase an annuity you choose the level of RCV that you require. For instance, you can choose to have 100 per cent RCV, which means that the full amount of your capital will be returned to you or your estate at the end of the annuity period. Or you may choose zero RCV, which means that all of your capital will be returned to you through your regular annuity payments. It is possible to nominate any RCV amount between zero and 100 per cent. For example, you may nominate a 50 per cent RCV which means that 50 per cent of your capital will be paid to you through the regular annuity payments and the remaining 50 per cent will be paid to you or your estate when the annuity expires.
What happens if you die?
When you purchase an annuity you may be able to nominate another person to receive an income upon your death. This person is called a ‘reversionary annuitant’. If there is no reversionary annuitant when you die, what happens depends upon the type of annuity. This nomination can be made in the application process but should be considered in your Estate Planning process as well.
For a lifetime annuity, where death occurs within the guarantee period, the residual amount of the annuity will be paid to your estate. Where death occurs after the guarantee period has passed, no further income is payable and any capital remaining is forfeited to the life insurance company. For a term certain annuity, the remaining income or lump sum equivalent is paid to your estate.
How are annuities taxed?
Annuity payments are taxed as ordinary income in your hands, with certain tax concessions available if superannuation money was used to buy the annuity. Part of your annuity payment, called the deductible amount, is not taxed when you receive it.
For superannuation annuities, if you are aged 55 to 59, you will receive a tax rebate of 15 per cent on the taxable amount of annuity payments. When you reach 60 your superannuation annuity becomes tax free.
What to do now..
The experienced advisers at Continuum Financial Planners Pty Ltd are able to provide more information about annuities – and if you would like to have an evaluation made as to the relevance and benefits to you of purchasing an annuity, you should phone 3421 3456, or use the website Contact Us facility to arrange a meeting: our advisers work to the mantra – ‘we listen, we understand; and we have solutions’ that is delivered with personalised, professional wealth management advice; and backed up with agreed Ongoing Service on a flat-dollar fee for service basis.
(This article was originally posted to our website in August 2009: it has been refreshed in December 2013.)